David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies LUSTER LightTech Co., LTD. (SHSE:688400) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for LUSTER LightTech

What Is LUSTER LightTech's Net Debt?

The image below, which you can click on for greater detail, shows that LUSTER LightTech had debt of CN¥16.3m at the end of September 2023, a reduction from CN¥87.0m over a year. However, it does have CN¥2.07b in cash offsetting this, leading to net cash of CN¥2.05b.

How Healthy Is LUSTER LightTech's Balance Sheet?

According to the last reported balance sheet, LUSTER LightTech had liabilities of CN¥759.9m due within 12 months, and liabilities of CN¥225.3m due beyond 12 months. Offsetting this, it had CN¥2.07b in cash and CN¥1.35b in receivables that were due within 12 months. So it actually has CN¥2.43b more liquid assets than total liabilities.

This surplus suggests that LUSTER LightTech is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that LUSTER LightTech has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact LUSTER LightTech's saving grace is its low debt levels, because its EBIT has tanked 91% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if LUSTER LightTech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. LUSTER LightTech may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, LUSTER LightTech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that LUSTER LightTech has net cash of CN¥2.05b, as well as more liquid assets than liabilities. So we don't have any problem with LUSTER LightTech's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with LUSTER LightTech .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.